Surplus pledge keeps pressure on RBA

Wayne Swan’s unwavering commitment to balance the budget in 2012-13 keeps the pressure on the Reserve Bank to cut interest rates.

As the Treasurer says, the fall in commodity prices has cut into tax revenue and forced the government to find further savings to deliver its budgeted surplus of 0.1 per cent of gross domestic product in 2013-12.

The size of the hole made in the government’s expected tax revenue in this financial year and 2013-14 has been reduced by the rebound in iron ore prices over the past 2½ weeks. Iron ore spot prices have regained about half the ground lost between June and early September.

Based on projections by the Bureau of Resources and Energy Economics, the fall in iron ore and coal prices could reduce the federal government’s revenue by about 0.3 per cent of gross domestic product in 2012-13, and by about 0.6 per cent of GDP over the next two years.

The economic impact of the Gillard government’s savings will depend on where they fall. If, as seems likely, it targets the tax breaks of higher-income earners, the impact will tend to fall on saving rather than consumption, and the effect on growth should be relatively small in the short term. The same is true of deferrals of spending on imported defence equipment and the like.

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Of course, there is a risk that the government is creating long-term problems. For example, the tax breaks on saving by higher-income earners were designed to overcome Australians’ tendency to save too little. The higher-income earners do most of the saving. Similarly, deferring defence purchases does nothing for fiscal sustainability.

Beyond the immediate horizon of the fiscal year, the quality of the decisions will be even more important than their short-term impact on the budget’s bottom line.

But for the RBA the concern necessarily is with the impact of fiscal policy on economic output and inflation over the next two years.

The savings needed to balance the budget in the next two financial years are now more manageable, but they will be in addition to all the other sand that is being thrown into the economy’s wheels from the truncation of the mining investment boom, the global economic uncertainty and the strong dollar.

With inflation already low, the RBA will cut rates to support economic growth. That will help exchange rate- and interest rate-sensitive activities including housing, manufacturing and tourism.